A common argument in favor for minimum wage is that a legally established wage is necessary because firms underpay low-skilled workers. How do they know these workers are underpaid? Because those workers say so. Why are they underpaid? Because they lack market power. Minimum wage, some proponents argue, merely correct this.
However, from an economic point of view, this argument doesn’t hold much water.
Remember that a worker’s compensation is determined by his productivity. A more productive worker will earn more. The only way for a worker to be underpaid is if he is making less than the marginal productivity he adds to the firm (this is true for everyone from the minimum-wage intern janitor to the CEO).
If a worker is underpaid, this creates a profit opportunity for a rival firm. If the rival firm sees a worker is underpaid, he can make a higher offer to the worker (one more in line with his productivity) and entice the worker away. In fact, firms do this all the time: it’s called headhunting. Due to this threat from rivals, it incentivizes the employee’s current firm to pay him what he’s worth or lose him.
This theory holds true even for minimum wage workers: minimum wage establishments compete with one another for business and employees. If one firm is perpetually underpaying its employees, it will face heavy turnover.
Some minimum wage workers (and many minimum wage proponents) feel the workers are getting a raw deal, that they are underpaid. I suggest a simple test to determine if this is true: look for another job. If a worker is able to find a higher-paid job, then he was underpaid at his old job. If he is unable to find a higher paid job, then his perceptions about the value of the service he provides (in this case, his labor) is incorrect.
Sometimes a person will value his labor higher than it actually is. Simply because he incorrectly overestimated his price does not mean he lacks market power; it simply means he overestimated.